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A Eulogy for Cap-and-Trade July 1, 2010

Posted by Jamie Friedland in Climate Change, Coal, Congress, Politics.
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Although it appears that immigration is cutting in front of energy on the legislative agenda, earlier this week, President Obama told Congress that he wants an energy bill that puts a price on carbon and reduces greenhouse gas emissions by the end of this year.

Cap-and-trade is the best way to accomplish this goal.  That is why the House passed the Waxman-Markey American Clean Energy and Security Act over a year ago.  Yet pundits have long ruled this elegant policy tool dead.

At this point, it seems that only a sea change within the Senate could ever bring cap-and-trade back again.  Before it receives its final judgment, it’s worth taking a look back at how this all started, how we got here, why it seemed like a good idea at the time, and why it still is.

Tom Crocker conceived of the cap-and-trade system as a graduate student at the University of Wisconsin in the 1960s.  In the 1990s, it was applied with great success to control sulfur dioxide emissions from American coal plants that were producing acid rain.  Our sulfur dioxide cap-and-trade system achieved greater reductions than expected at less than half the projected cost. The Economist dubbed it “probably the greatest green success story of the past decade” in July 2002.

Here in the US, cap-and-trade efficiently reduced sulfur dioxide emissions for a fraction of the projected cost.

The EU implemented a greenhouse gas cap-and-trade system in 2005 with mixed results.  But it is a rare step in the right direction and a valuable first try from which we can learn many important lessons.  To co-opt a Republican oil spill talking point, one plane’s turbulence shouldn’t preclude air travel.  We can rebuild it.  We have the technology.

A number of key Republican senators have stated that they will never vote on any energy policy that includes cap-and-trade.  This is an unabashed flip-flop for which they have not been held accountable. Many of these senators supported cap-and-trade before they started calling it a “job-killing energy tax.”

Point of clarification for Republicans: carbon dioxide is not energy.  It is a waste product and pollutant being dumped into a vital resource.  Cap-and-trade is no more an “energy tax” than charging people who pumped cow manure into our drinking water would be a “beef tax.”  Also, it creates jobs. Other than that though, “job-killing energy tax” is a perfect characterization.

Recent cap-and-trade “debates” have lacked relevant historical context; in 2003 John McCain cosponsored the first climate cap-and-trade bill, for crying out loud.  The theory remains unchanged, the only new development is these senators’ adherence to Republican lies talking points.  Blatant, partisan flip-flops are well-documented by McCain, Richard Lugar, Lindsay Graham, Scott Brown, and even Lisa Murkowski!

For decades, conservatives railed against “heavy-handed” traditional environmental regulations.  Known as “command and control” regulations, these laws mandate one solution for a given problem, regardless of the circumstances.  For example, if a factory emits too much of a given pollutant, by law it must install a specific type of scrubber to reduce that pollution, even if cheaper alternatives could produce that same emissions reduction.

While appropriate in many situations, economists and conservatives have argued against such regulations because they can be inefficient and impose higher costs than necessary upon businesses.  This is a valid criticism.  It is the reason why economists prefer and advocate for “market-based instruments” (MBIs) – such as cap-and-trade.

Market-based instruments, as their name implies, utilize markets for environmental regulation.  They are preferable to command and control regulations because markets enable us to achieve emission reductions as efficiently (i.e. cheaply) as possible.

Command and control regulations stifle innovation.  They mandate the use of a specific technology, and that is that.  In contrast, MBIs foster and catalyze innovation.  Cap-and-trade presents a great example.

Once we put a price on carbon pollution, it is suddenly within industries’ interest to invest in ways to cheaply reduce their emissions.  Instead of dictatorially deciding what technology to use, we unleash our nation’s intellectual resources upon this challenge.

Under cap-and-trade, cheaper emission-reducing solutions are developed and utilized.  And the benefits don’t just accrue for industry.  Third parties stand to gain from developing these technologies for them, so MBIs incentivize the creation of startups and the expansion of small businesses attempting to reduce carbon output and increase efficiency – and obviously spur renewable energy technologies for our future.

But just how does cap-and-trade put a price on carbon?

If you know how a cap-and-trade system functions, you will want to skip to the last paragraph.  If you’ve heard the phrase everywhere but aren’t really sure exactly what is entailed, I have provided a description here.

The Cap:

Regulators determine how much pollution the country is allowed to emit in a year.  Then they distribute permits for emissions up to that amount (the distribution method is a complicating factor that I will discuss below).  Because a fixed number of permits are issued, this system has the benefit of ensuring emission reductions (as opposed to a carbon tax).  Polluters want to emit a given amount of pollution but there are only so many permits available.  This creates a market for carbon pollution.  That market puts a price on emitting carbon and also provides a long-overdue economic disincentive to pollute.

A carbon tax also puts a price on carbon, providing some but not all of these same benefits.  A carbon tax is an inferior carbon control mechanism.  If you are interested in why this is or dispute this point, I could easily throw together a cap-and-trade vs. carbon tax post.

The Trade:

Suppose, for example, that there are two factories (see the graphic below to visualize this example).  One is ancient and spews pollution (Plant A) – making emission reductions at this factory is very expensive.   The other is brand new and could easily be upgraded to drastically cut its carbon emissions (Plant B).

Under traditional, command and control regulation (left example), it would be very expensive to bring the older factory into regulatory compliance.  Yet under a cap-and-trade system (right example), we could let the newer plant reduce its emissions for both itself and reduce its emissions further on behalf of the older plant.

In this cap-and-trade example, our polluters have permits entitling them to emit a certain amount of pollution.  In this scenario, the newer plant emits even less pollution than it has permits for; it has cleaned up so much that it has permits to spare.   So the older plant could pay the newer plant for offsetting its continued emissions (the newer plant sells its unused emission permits to the older plant).

Because paying the newer plant is cheaper than making further upgrades to the older plant would be, the same emissions reduction under command and control regulation is achieved for a fraction of the price using cap-and-trade.  And the system operates efficiently because we allow the market to determine the price of the permits.

Permit Distribution:

How these pollution permits would be distributed is the biggest source of contention within cap-and-trade proposals.  There are three ways to distribute credits:

1) Auction – companies bid for every one of the permits they think they need.

2) Allocation – the government gives away permits to polluters for free.

3) Grandfathering – permits are allocated based on historical emissions.  This accomplishes nothing because there is no incentive to reduce emissions, but it has been lobbied for heavily by major polluters.

Serious cap-and-trade proposals have included a mix of these distribution options.  From a climate change perspective, a pure auction is the best solution.  It raises the most money to help offset costs to consumers and spur research and development of renewable energy technologies while providing the most incentive to reduce emissions.  But direct allocations are attractive to legislators because it lets them in a sense “buy” the support of different groups that otherwise would not support the bill because they would be more greatly affected.

Some of this allocation falls into the realm of necessary political compromise, but it is also this aspect of previous climate bills that has doomed them in the contorted, propagandized public perception.  That being said, instituting a cap-and-trade system without any initial allocation would impose heavy costs on industry all at once.  I’m not saying they don’t deserve to pay for the free ride they have enjoyed for centuries, but helping them make the transition is not an outlandish idea.

Conclusion:

In any case, this all may be a moot point because cap-and-trade’s prospects in the Senate are beyond dim as long as Republicans stick to those guns they love so much and Democrats do not control a supermajority (and probably still even then).

I wrote this post because as this policy dies at the hand of partisan politics, it needs to be said that this was our best vehicle to address climate change.  Study after study have shown that cap-and-trade bills would tackle our climate pollution while reducing the deficit, creating jobs, and increasing our energy security.

But who wants that?  Not Republicans, apparently.

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